BLACK FRIDAY HOLIDAY READING: CHINA WIND V. AMERICAN HITECH – A STILL UNFOLDING STORY OF INTERNATIONAL ESPIONAGE AND THEFT

Some original reporting:

A Tale of Intrigue and IP Theft in the Wind Market; Did Sinovel steal American Superconductor’s intellectual property and breach its contract?
Herman K. Trabish, September 16, 2011 (Greentech Media)

The arrest of an American Superconductor (NASDAQ: AMSC) employee in Austria who is accused of passing software secrets to Chinese wind giant Sinovel has resulted in the filing of criminal and civil complaints in China against Sinovel by AMSC.

In criminal and civil complaints filed against Sinovel “and other parties,” U.S. wind turbine and electrical control system provider AMSC alleged the illegal use of its intellectual property and violation of contractual obligations.

“We have evidence that senior-level Sinovel employees engaged and paid an AMSC employee who illegally transferred some of our intellectual property,” AMSC President and CEO Dan McGahn said. “This individual appears to have turned over a portion of the upper layer, or binary code, of our PowerModule software and the source code we developed specifically for Sinovel’s 1.5-megawatt wind turbines.”

Using AMSC’s code, McGahn said, Sinovel upgraded its turbine control system with a new AMSC program developed to meet newly proposed Chinese grid standards. “We have compelling evidence that Sinovel has already utilized this stolen intellectual property to upgrade hundreds of its 1.5-megawatt wind turbines,” McGahn said, adding that the Chinese company “may also be looking to alter our source code to open the platform and allow the use of power electronics from other manufacturers, such as Guotong, a company founded by Sinovel.”

Sinovel licensed its 1.5-megawatt platform from Fuhrlander in 2005 and has since made thousands of the turbines. AMSC supplied the core electrical components with its proprietary (and heavily encrypted) power converter and control systems.

When suspicions were raised in mid-June, McGahn reported, AMSC began a criminal investigation in conjunction with law enforcement. “After compiling extensive evidence, we brought our issues to the attention of U.S. and Chinese authorities.”

The arrested employee worked in Austria, where AMSC subsidiary Windtec is based. He “is currently in jail awaiting trial on criminal charges that include economic espionage.”

McGahn said the investigation made clear that AMSC’s encryption was effective. “Outright theft was necessary,” he reported bluntly.

There have been significant indications that Sinovel, long China’s biggest wind turbine manufacturer, is struggling.

“The China wind market has slowed and it’s clear that Sinovel’s business is off,” McGahn said. “Their financial performance has weakened” and there are “clear signs of strain,” he went on, adding, “now Sinovel has compounded its troubles by stealing.”

click to enlarge

AMSC, too, has been struggling since April when Sinovel, formerly AMSC’s biggest customer, refused a major shipment. “During the spring, we repeatedly attempted to reach a resolution with Sinovel on its contractual breaches,” McGahn said. Negotiations were fruitless, but they became pointless when AMSC discovered evidence of theft.

In its filings, AMSC is “asking for an order requiring Sinovel to meet its contractual obligations.” In addition, they are asking legal authorities in China to compel Sinovel to cease and desist from infringing its intellectual property and pay monetary damages and compensation for economic losses. “We are seeking full restitution,” McGahn said.

“AMSC is now operating its business based on the assumption that Sinovel will not be a customer,” McGahn said. “Customers pay their bills and customers respect intellectual property.”

On the other hand, McGahn quickly pointed out, AMSC’s actions do not represent a statement “on China wind or China in general,” he said, noting continued strong commitments to Chinese wind customers Dongfang, XJ Group, Shenyang Blower Works and JCNE. “It is an economic reality that we must do business in China, and I believe we can do it securely and profitably.” In fact, he added, the experience with Sinovel has left them “better prepared to succeed in China than ever before.”

In response to this setback, McGahn said, AMSC has trimmed 30 percent of its employees, streamlined management, cut its annual cost structure by $30 million since the start of the fiscal year and -- most importantly -- instituted “new, conservative financial controls, which include the requirement for letters of credit or bank guarantees before shipments to China.”

They have also “realigned the business” from a focus on power system and superconductor technologies to a focus on the wind and grid markets the technologies serve, creating a more customer-oriented business.

McGahn said the legal actions were filed in China because the turbines with the allegedly stolen software are “almost exclusively in China and it is a Chinese contract.” He described the lawsuits as pertaining to trademark and copyright infringements, not patent violations.

On the challenge of facing off against a Chinese company in the Chinese legal system, McGahn said AMSC had done “a lot of work on collecting the evidence” and “being cognizant of what we’re going to have to do in China.”

He noted the recent legal victory in China by telecom giant Cisco. “Cisco had a complaint about IP theft with a major Chinese telecommunications provider,” he said. “There was in my opinion less evidence than what we have, but Cisco was able to prevail and win a settlement with the company that had stolen their intellectual property. So there is precedent and our lawyers believe we have an extremely strong case.”

“Chinese companies really do value Western technology,” AMSC Communications Vice President Jason Fredette recently told Greentech Media in an eerie premonition of AMSC’s fate. By providing that technology, Fredette said, AMSC expected to be a part of China’s international pace-setting wind and transmission build-out. “The vast majority of AMSC’s revenues are coming directly from China.”

Not so much now.


Wind Power: AMSC Employee Pleads Guilty to Passing Code to Sinovel; Austrian court convicts; “criminal acts” and “industrial espionage” described.
Herman K. Trabish, September 26, 2011 (Greentech Media)

D.I. Dejan Karabasevic, an engineering graduate of the University of Belgrade and an employee of AMSC Windtec GmbH, pled guilty Friday in Klagenfurt, Austria, to charges associated with passing proprietary information to Chinese wind turbine giant Sinovel for remuneration.

As a result of trips to China from 2006 on, Karabasevic developed close ties with Sinovel personnel. He was arrested in Klagenfurt on July 1, 2011, for passing to Sinovel an upgraded version of AMSC’s C12 1.4.3 code which allowed Sinovel to add a Low Voltage Ride Through (LVRT) function to its 1.5-megawatt turbine crucial to meeting upgraded Chinese grid requirements.

The upgrade allowed Sinovel to cancel its contracted orders for turbine electronics with AMSC Windtec just at the time in the spring of 2011 when activity in the Chinese domestic wind market was contracting and Sinovel needed to reduce its overhead.

According to the indictment, Karabasevic admitted to having copied parts of the code and to receiving remuneration for passing it to Sinovel.

Furthermore, the indictment stated that “criminal acts committed by the accused constitute the offence of industrial espionage for the benefit of a foreign country” because “Karabasevic was fully aware of the criminal nature both of the acts committed by him and of their results … when he carried out his ‘industrial espionage’ and accepted the damage to Windtec and to the Austrian economy that he knew would result from them.”

Finally, the indictment indicated that “criminal acts admitted by the accused constitute sufficient evidence to show that the civil claimant, Windtec, has suffered damage in the amount of at least €6 million.”

click to enlarge

A Sinovel statement released before the conviction said it denied AMSC’s allegations of illegal use of intellectual property rights and promised “to actively respond” to suits filed in China by AMSC for breach of contract and theft of intellectual property.

Sinovel’s statement justified its actions by claiming AMSC had “failed to implement obligations to Sinovel” with timely technology upgrades. This, Sinovel’s statement asserted, forced them to develop their own LVRT solution.

“We stand behind our products and our customer service,” Jason Fredette, Vice President of Marketing and Communications for AMSC, said in reply.

In response to Karabasevic’s confession, Sinovel released a statement describing his “claims” as “completely false” and insisting “Sinovel has never bought over any business secrets or intellectual property rights from the AMSC employee.” It added that the charges brought by AMSC and Karabasevic “have seriously violated Sinovel’s public image and business reputation,” adding that “Sinovel reserves the right to legal actions.”

Regarding the code and the LVRT, the Sinovel statement said that “more than five years of development” and “the dedication of over 800 engineers” put Sinovel “technically far ahead of the industry” and without any need for “AMSC’s trade secrets or intellectual property rights.”

With Karabasevic’s conviction, it would seem the Austrian court’s judgment was that Sinovel’s 800 dedicated engineers were somewhat redundant to the code development process.

On the same day Karabasevic was convicted, AMSC noted some $100 million in new contracts since the April 1 start of its fiscal year 2011: “Within its wind segment, AMSC signed contracts with wind turbine manufacturers in China, India, Korea and Taiwan. Within its grid segment, AMSC received orders for its grid interconnection and high voltage stability solutions in the U.S. and Europe and made a key high temperature superconductor wire shipment to South Korea.”


Can AMSC Recover From Alleged IP Theft by China’s Biggest Wind Company? “An important litmus test for future energy cooperation between China and the West”
Herman K. Trabish, November 14, 2011 (Greentech Media)

Though Chinese courts will make the final determination, the confession and conviction of a former employee of AMSC subsidiary WindTec for intellectual property (IP) theft and collusion with Sinovel, China’s biggest wind manufacturer and the second biggest in the world, make it difficult to discredit AMSC’s version of events.

“Consider the evidence,” said AMSC President/CEO Dan McGahn of the company's cumulative $1.2 billion case against Sinovel. “We have hundreds of emails and messages between senior-level Sinovel staff members and our now-incarcerated former employee.”

The messages, McGahn said, show Sinovel requested the stolen IP and that senior-level Sinovel employees knew the IP was obtained illegally and would damage AMSC. And there is physical evidence: signed contracts with Sinovel and related parties promise the employee more than $1.5 million, and emails contain the actual IP transfer.

“We will share with the courts,” McGahn said, “evidence from multiple wind farms in China demonstrating that Sinovel has been utilizing this stolen software to upgrade its wind turbines.”

Meanwhile, AMSC is fighting for its life. In the second quarter (2Q) of fiscal year 2011, which ended September 30, revenues were $20.8 million, barely twenty percent of the $98.1 million for 2Q 2010.

On the hopeful side, the figure was more than twice Q1’s $9.1 million.

“The year-over-year decline is due primarily to a lack of revenue from AMSC’s former customer, Sinovel,” AMSC admitted.

But, perhaps more importantly, “The quarter-over-quarter increase was driven by solid growth in both of the company’s reporting segments (wind and grid).”

AMSC is fighting back in the business and legal arenas.

In the legal arena, it is pursing suits worth more than $1.2 billion.

“We filed for arbitration with the Beijing Arbitration Commission,” McGahn said, “seeking nearly $70 million in compensation” and requesting the courts to enforce existing contracts worth “over $700 million.”

In Beijing and Hainan Province, AMSC is bringing “two civil suits for copyright infringement,” McGahn said, against “Sinovel, a wind farm developer that is using turbines containing our stolen IP, and Guotong, a company that Sinovel has invested in to manufacture systems that compete with our own.” In these cases, AMSC wants cease-and-desist orders and $6 million in damages.

click to enlarge

Finally, a trade secret case against Sinovel and members of its senior-level staff in the Beijing Higher People’s Court seeks more thsn $450 million in damages.

“Each of our cases has been accepted and proceedings are expected to begin later this year,” McGahn said, adding that the AMSC suits are widely seen as “an important litmus test for future energy cooperation between China and the West.”

In the business arena, AMSC is restructuring and divesting across the board. It estimates balance of cash, cash equivalents, marketable securities and restricted cash will exceed $75 million at calendar year-end. “We believe we have sufficient cash,”said Senior Vice President/CFO David Henry, “to fund our operations and capital expenditure requirements for at least the next 12 months.”

In 2Q 2011, McGahn said, the company “got back to growth” and “significantly lowered our headcount and our cost structure.” The company’s leaders “dealt with our new financial reality by streamlining and flattening our management.”

It also terminated its proposed acquisition of The Switch, a Finnish engineering company, at a cost of $20.6 million.

The economic environment is still challenging, but, McGahn said, “The wind power and power grid markets will continue to attract tens of billions of dollars in annual investment,” adding: “AMSC is well positioned to benefit.”

A new report from Pike Research affirmed this. “Overall capacity will continue to rise at a healthy pace,” the report said, and “by 2017 wind power installations will represent a $153 billion global industry, up from $77 billion in 2011.” In that period, the wind industry’s cumulative new investment is expected to total some $820 billion.

Having learned its lesson from the Sinovel incident, AMSC is developing customer diversification. Whereas Sinovel was over 70 percent of AMSC’s revenue, no company now represents more than about ten percent.

In 2Q 2011, AMSC retained wind turbine manufacturing customers (Inox Wind in India, Doosan Heavy Industries in Korea and Dongfang Turbine Company in China) and grew its superconductor business (in South Korea with Korea Electric Power Corporation and LS Cable & System, with the U.S. Department of Energy and partners Nexans, Siemens and Air Liquide, as well as with the Department of Homeland Security and partners ConEdison and Southwire).

Baird Equity Research noted that AMSC faces “significant challenges.” The wind business, it said, continues to drive the company's growth. Superconductor projects are in the pipeline but won't be major contributors until after 2012. Baird noted other concerns, including “limited visibility into Asian operations,” a “declining cash position,” potentially faltering government subsidies and “risks associated with international operations.”

One factor could be determinative. The plundering of AMSC’s IP was driven by Sinovel’s urgent need to adapt to China’s new, more rigorous grid standards. AMSC’s technology was clearly deemed invaluable for compliance.

This suggests that if AMSC can win its right to compete in the Chinese courts, it has the right technology to be strongly positioned to rise again in the business arena.

“To put it mildly, my first full quarter as CEO was eventful,” McGahn said. “Certainly more hard work lies ahead,” he added. “But, I can assure you, we’re up for the challenge.”